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The “hidden” side of the “flying-geese” catch-up model: Japan’s dirigiste institutional setup and a deepening financial morass Terutomo Ozawa Professor of Economics Colorado State University Fort Collins, CO. 80523-1771 Phone: (970) 491-6075 Fax: (970) 491-2925 E-mail: [email protected] July 2001 JEL classification: O14; F02; F21; O53 Keywords: Flying geese model; dirigiste regime; institutions; financial crisis The author owes to Hugh Patrick of Columbia University for his meticulous, detailed and valuable comments, which have led to many improvements in this article—and is also appreciative of the constructive suggestions and encouragement received from an anonymous referee. Any remaining errors are solely of the author. This article was drafted while he was a visiting fellow at the East-West Center, Honolulu, Hawaii. An early version was presented at a seminar held at the Center. He is indebted to seminar participants, especially Dieter Ernst, theme leader, for their comments. 1 ABSTRACT Akamatsu’s original “flying geese (FG)” growth model is often used as a frame of reference for both further conceptual elaborations and empirical explorations. So far have only the positive side and results of FG development been focused on and emphasized in connection with Asia’s phenomenal growth in the pre-crisis period. The Japanese economy, supposedly Asia’s lead goose, is in the eleventh consecutive year of stagnation. How has such a once successful lead goose come to be stricken by financial woes? This paper points out that Japan’s once miraculous FG growth was made possible because it established an effective dirigiste catch-up regime in the early postwar period but that Japan’s present financial predicament is paradoxically a path- dependent outcome of such an FG strategy. The institutional, especially financial, dimension of FG strategy needs to be taken into account to explain why such a strategy once proved effective but later culminated in a deepening financial morass. The FG model should encompass not only the industrial dimension of catch-up but also its institutional, particularly financial, dimension. 2 1. Introduction Japan is in the eleventh year of stagnation with a prolonged financial malaise. However, Japan’s phenomenal growth was once admired and even feared as a juggernaut. Japan and the rest of Asia grew in tandem and basked in clustered regional prosperity, which the World Bank (1993) called the “East Asian miracle.” One popular way of explaining such regionally agglomerated growth was the so-called “flying-geese (FG)” model of economic development. As pointed out in Kojima (2000), however, the FG model is incomplete in many respects, especially in its financial dimension. Ever since the start of the 1990s Japan, supposedly Asia’s lead goose, has been mired in a self-inflicted financial crisis ever since the bubble of 1987-1990, which is now made all the more dangerous with a “triple deflation”—simultaneous declines in the prices of goods, property, and equity shares. On March 19, 2001, the Bank of Japan had to adopt drastic monetary policy to flood the economy with liquidity, an unprecedented measure designed to prevent “price destruction” in hopes of stimulating demand. This paper argues (i) that the FG model of catch-up growth, though instrumental in depicting the essential features of latecomers’ (notably Japan’s) industrial upgrading and Asia’s export-led growth, has so far neglected its financial/institutional dimension, and (ii) that the success of Japan’s FG growth derives critically from a special set of institutional arrangements that was created in the early postwar period, and (iii) that Japan’s present financial imbroglio is paradoxically the very vicissitudinary outcome of such an FG-specific regime. 2. “Flying-geese” Catch-Up Strategy As already often cited, the FG model of economic development was originally introduced by Kaname Akamatsu in the 1930s (inter alia, Akamatsu 1935) and has been theoretically expanded and empirically tested by his followers, as detailed in Kojima (2000) in this Journal. It is worth re-emphasizing that Akamatsu was among the very first to recognize the economic significance of what he identified as “the alignment from advanced nations to backward nations according to their stages of growth”: he argued that “It is impossible to 3 study the economic growth of the developing countries in modern times without considering the mutual interactions between these economies and those of the advanced countries” (Akamatsu 1962, p. 1, emphasis added). He did not, however, leave any formalized theoretical model to explain his ideas. The FG analogy came from his empirical findings of the “import->domestic production->export (M-P-E)” pattern of sequential growth in some prewar Japanese industries (such as textiles), which he identified as the basic FG pattern. In essence, what he had in mind was an evolutionary model of sequential catch-up through teacher-learner relations among the nations along the stages of industrial upgrading. It was a model of derived economic development via emulative learning in a latecomer nation. The catch-up regime Japan set up after the Second World War, however, was rather a nationalistic dirigiste one, since the M-P-E sequence (namely import-substitution-cum-export promotion) was purposely state- assisted—and promoted as a dynamic “infant industry” development strategy. It is true that Japan’s industrial development policy was basically private-sector-assisting and “market-facilitating/creating” (Gregory 1986) or “market-enhancing” (Aoki, Murdock, and Okuno-Fujiwara 1997). Nevertheless, it involved extensive restrictions on imports, technology transfers and inward foreign direct investment (FDI)--all for the purpose of building up national (not foreign owned) domestic industries. This role of the government was significant, particularly when Japan modernized and rebuilt capital-intensive heavy and chemical industries, industries that it had previously succeeded developing in the prewar years. Emulation was the essence of Japan’s FG strategy, capitalizing on its latecomer status in learning from the West. Akamatsu himself did not directly prescribe such strategy, but Japan’s catch-up policy was formulated and pursued in the spirit of his original insight (Korhonen 1994). Japan’s postwar policies have been well explored (inter alia, Komiya et. al. 1990; Patrick and Rosovsky 1976). Japan’s FG strategy can be re- interpreted as consisting of three critical types of industrial policy by drawing upon Akamatsu’s original triumvirate FG patterns: the M-P-E sequence, the “from crude/simple to complex/refined articles” sequence (which is industrial upgrading) and the “alignment of nations along the different stages of development”: (i) a policy for industrial upgrading (IU) from low value-added (low productivity) to higher value-added (higher productivity) industries, 4 (ii) a policy for import-substitution-cum-export-promotion (IS-EP)--that is, to replace imports with domestic output and later to promote exports,1 and (iii) a policy to transfer comparatively disadvantaged industries or industrial segments onto other countries (mostly nearby developing Asian countries) so as to retain higher value-added industries at home, a process that may be identified as comparative advantage recycling (CAR) and adaptive efficiency enhancement (AEE) at home. Obviously, the outcomes of these policies were closely and sequentially interrelated. IU policy is the ultimate goal of the FG strategy. And IU can be accomplished by both the IS-EP sequence and the CAR-AEE mechanism. Once a new comparative advantage (commensurable with Japan’s prevailing factor endowments and technological conditions at a given point in time) was created out of formerly disadvantaged industries through the IS-EP policy, Japan continued to foster other future growth industries at home—that is, to move up the ladder of IU. And once export industries (or industrial segments) began to loose competitiveness (i.e., become comparatively disadvantaged), they were transplanted via overseas investment onto other countries, especially the developing Asian countries, where the factor endowments and technological conditions were still suitable for such industries. What is more, those goods transferred and produced overseas are now imported back to home—hence, the IS-EP policy eventually turned to the sequence of “import->domestic production- >export->overseas production via FDI ->import” by going beyond Akamatsu’s original M-P-E. In the meantime, the resources released from the contracting (now disadvantaged sector) are shifted to newly emerged competitive sectors (i.e., AEE). What is involved is not static allocative efficiency (i.e., movement along a given product possibility frontier) but dynamic adaptive efficiency (i.e., a biased shifting-out of the product possibility frontier along the Rybczynski path). This adaptive efficiency was pursued as an infant-industry protection strategy in a market- 1 In this trade-focused development of a specific good or industry, critical technology was acquired in an “unpackaged” manner, that is, mostly under licenses. Later on, the sequence required no initial imports of goods and shifted to that of basic technology acquisition->commercialization at home (i.e., domestic production)->export, as best seen in many of Japanese innovations such as transistor radios, pocket-size calculators, quartz watches, etc. In this later version, government role declined, while adaptive